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Thursday, November 12, 2009

Investors Countinue to Pour Money into Bonds

According to this report from Morningstar, investors continue to pour money into fixed income funds and out of equities. Amazingly though more money has come into the market this year then was pulled out in 2008, but just about all of the gains went directly into bonds. Anybody think the retail investor is right this time?

With the economy starting to recover and interest rates at record lows, it seems like an odd time to be invested in bonds. Do people realize that bond funds lose money as interest rates rise? Bonds are the worst investment in rising rate environments. Wanna bet that the media convinced everybody that the market had come too far, too fast going into September/October. That bonds offer safety in a volatile environment. That bonds did better during the crash. Poor sheep listened again.

Also, most people don't understand the difference between a bond and a bond fund. A bond in theory doesn't lose value as long as your willing to hold till maturity. You collect the payments and don't really care about the trading value. Unless of course you've got a bond from some company about to stop paying. That's a completely different discussion though. A bond fund on the other hand is all about trading value. Its value is updated daily based on what you could sell the bonds for at the closing each day. Basically mark to market versus hold to maturity. Mark to market can be brutal as we saw last year.

Back to the details of the report:

Most of the money flowing into fixed income funds came from the record $3.6T in money market accounts in January. That total is now down to a still very high $3.2T.

Bond funds had an inflow of nearly $42B in October and $296B YTD.

Equity funds had a $3B outflow in October and only $12B inflows YTD.

Domestic equity funds were decidedly negative with net outflows YTD of over $4B.

International equity funds fared much better with inflows of $16B YTD.

This leaves one to wonder what happens when money flows into equities and domestic funds in particular. Even though stock markets are up huge off the lows, nobody has been convinced to join from the sidelines. As we wrote about the Yield Curve in our previous article, this might sum up why equities tend to do well in the initial phases of interest rate hikes by the fed. All this money in fixed income is likely to come flooding out as bonds begin losing value. The money must find a home with the options of either next to nothing in money market accounts or the 'promise' of big returns in equity funds (nobody tell them that they are late to the party yet again).

p.s. Just don't tell these party crashers until I have my clients money out of the market.